The history of the financial crisis tells a disturbing tale for those who hold dear prosperity and democracy.
Although this should have been the moment for representative governments to rise to the occasion, too often political leaders failed to take the actions needed to preserve the welfare of those who elected them. The institutions that did the most to help economies recover were the most technocratic and without a direct popular mandate: the central banks.
The feeble response by democratically elected government, and the resulting ascent of the central banks, has produced two results. Mainstream politicians have squandered their moral authority, giving rise to populist forces both in Europe and in the US.
Meanwhile, the world’s leading monetary authorities have faced accusations of overreach, which will not go away so long as central bankers keep the powers and the instruments they have obtained. As Paul Tucker, a former deputy governor at the Bank of England, has written in a new book, “Unelected Power,” “Central bankers have become ‘overmighty citizens’ of whom too much is expected.”
From Japan to the US, central banks around the rich world slashed interest rates and bought vast amounts of assets as they sought to ward off deflation and restore growth. It has taken some time for this flood of cheap money to generate enough growth to heal the post-recession wounds, particularly in the euro zone. But most economists agree that in the absence of decisive intervention by the world’s leading monetary authorities, the Great Recession would have been much worse and lasted longer.
The record of democratically elected governments during the crisis was, by comparison, a lot patchier. True, after the initial decision to let Lehman Brothers fail, the US moved swiftly to recapitalize its banks and to provide fiscal stimulus to the economy. However, in other developed economies the reaction was less decisive: In the UK, for example, the Labor administration initially passed a program of spending increases and tax cuts to help restore the economy to health. However, this was quickly withdrawn by the coalition government of the Liberal Democrats and the Conservatives, who embarked on a punishing austerity drive that delayed the recovery.
The European Central Bank didn't exactly shine in its initial response to the crisis. Under Jean-Claude Trichet, the ECB chose not to embark on a large-scale asset purchase program, caving in to opposition from Germany. In 2011, it increased interest rates twice — a move that is now widely judged to have been premature and may have contributed to worsening the incipient sovereign-debt crisis.
However, as soon as Mario Draghi took over from Trichet, the ECB shifted gear. The new president quickly moved to soothe fears that the euro could collapse, famously saying that the central bank would do “whatever it takes” to keep the single currency intact. This calmed markets and helped the euro zone climb back from the economic crisis. The ECB then embarked on a program of quantitative easing, which avoided the risk of a deflationary spiral. If the euro zone is now finally in full recovery mode, the merits belong largely to its central bank.
Unlike the ECB, politicians did little to shake off their torpor. At the height of the sovereign debt crisis, troubled governments in countries such as Spain, Italy or Greece had to tighten their fiscal belts as they faced skyrocketing borrowing rates. Germany should have provided more fiscal stimulus for longer: Some of it would have spilled over to its euro-zone partners via higher exports, which would have helped to limit the extent of the recession.
Other countries shied away from passing much-needed structural reforms to boost the economy’s growth potential: In particular, Italy did little to reform its snail-paced justice system and public administration, which to this date severely limits its ability to attract foreign and domestic investment.
Supporters of democratic institutions could argue that the problem is not democracy per se, but the quality of politicians. Maybe Angela Merkel, the German chancellor, was just not brave enough to embark on a prolonged fiscal stimulus. Similarly, Mario Monti, Italy's prime minister at the height of the crisis, was quick in putting the public finances in order, passing a landmark pension reform, but then lacked the political courage to take steps that would boost his country’s competitiveness.
However, the problem limiting the ability of rich democracies to intervene in a crisis run deeper than a lack of leadership. Government debt levels have soared to almost 90 percent of gross domestic product in the euro area and more than 100 percent in the US, which severely limits the room to boost spending and cutting taxes during a future recession. Of course, this doesn’t mean that politicians cannot intervene if the necessity arises. However, they still need the crucial support of their central bankers, who will need to slash interest rates and, perhaps, restart their program of quantitative easing to keep borrowing costs low.
So the power of central bankers is here to stay. When the next crisis hits, politicians — even those with popular mandates — will depend more than ever upon the whims of unelected technocrats.
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